It
is important to understand the difference as to how debt can apply to you, how
debt can be collected from you, how costly debt can be to you, and how debt can
be defined. This article should help you understand the important
differences between debt forgiveness, debt obligations, and debt deficiency.
What is a Personal Debt
Obligation?
A personal debt obligation is an
amount of money legally owed to a lender that arises from a loan agreement. It
involves a continuing obligation to make payments until the debt is paid off in
full. A lender has the right to sue in order to collect any unpaid outstanding
debt. A debt obligation can be secured or unsecured.
A secured debt obligation involves the placement of a lien
against the debtors property, so a lender can force the sale of the property to
pay off the debt. An unsecured debt obligation has no security
against the debtors property which means a lender can only sue a debtor
personally to recover any monies due.
What is Debt Forgiveness?
Debt forgiveness is the partial
or total forgiveness of a debt. It means you no longer owe the debt to the
lender or any other party. The lender gives up its rights to collect the debt
and instead "writes it off" their books. Once a lender agrees to
forgive a debt, the lender will report the forgiveness to the IRS by filing a
1099 form.
What is a Deficiency Debt?
Deficiency debt also known as
debt deficiency arises when collateral that is used to secure a loan cannot
satisfy the total amount due on the loan. It happens most often with debt
involving real estate. However, it can occur in other types of collateralized
loans such as car, business, and equipment loans. When a loan goes unpaid, the
lender has the right to auction off the property to pay off the debt. If the
lender collects less than what is owed at the sale, the shortage is called debt
deficiency.
What are the consequences of a
Personal Debt Obligation?
You will continue to owe the
original amount that was borrowed plus any additional interest, late fees,
collections fees, penalties, and/or attorney fees that may come due. If the debt
obligation remains unpaid, then the lender can go to court, sue for a money
judgment, get a money judgment, and use any legally available collection
tactic. Most often, after a money judgment is awarded, a lender will attempt to
put a lien on a bank account or garnish wages or put a lien on the debtors real
estate. A lender can put a lien on business equipment. A debt obligation that
turns into a money judgment can last for many years. In New York, a money
judgment last for 20 years.
What are the consequences of Debt
Forgiveness or Debt Deficiency?
Whether it is debt forgiveness or
debt deficiency, the consequences are essentially the same. A lender has two
general options regarding any unpaid debt. 1. The lender can forgive the debt.
2. The lender can get a court ordered money judgment to chase the borrower for
the money or sell the debt to a third party.
If a lender agrees to forgive the
debt, the lender will, in all likelihood, file a 1099 form for the forgiven
amount. You should also remember to check your state taxing authority, since
your state may consider debt forgiveness as taxable income. If the debt is
secured by property, it may be possible to negotiate an exchange of the
property for the full debt balance. In this case, the lender would not have a
reason to file a 1099 form.
If the lender refuses to forgive
the unpaid portion of a debt, then the lender will try to collect on the
remaining balance. The lender can hire an attorney to sue for the remaining
debt or sell the debt to a third-party. If successful, a lender will get a
money judgment. There are various methods a lender can use to enforce
collection of a money judgment. They can request your financial records to see
if you have a job; to determine if you possess cash in the bank; or to locate
your property. If the lender can find anything you own or earn, it will be
seized or attached. The lender has the right to collect a fixed percentage of
your wages also known as wage garnishment. By the way, the lender does not need
you permission to garnish your wages. The lender simply contacts the payroll
department and demands that a portion of your salary go to the lender.
When there is a debt deficiency
from the sale of a property, the lender can forgive the difference or try to
collect the difference. A deficiency debt becomes a new personal debt
obligation unless a lender forgives the deficiency. Sometimes, a lender will
demand a property owner sign another loan agreement for a deficiency debt. The
IRS and some states offer tax relief to homeowners who have their debt
deficiency forgiven. There is more information provided ahead about tax relief
in this FAQ.
In our day and age, debt
collection is big business. Technology makes it easier to find anyone and to
find everything an individual earns or owns. There are third party companies
purchasing personal debt obligations and/or deficiency debt from lenders. These
third party companies may pay 10 to 20 cents on the dollar for the debt. Once
the third party company owns your remaining debt, under most circumstances the
third party has the same collection rights as the original lender.
Why does a lender issue an IRS
1099 form after Debt Forgiveness?
Debt forgiveness is considered
taxable income by the IRS and by certain state and municipal taxing authorities.
The IRS requires a lender to report the forgiven debt on form 1099-C,
Cancellation of Debt. Individuals are required to report any forgiven debt on
Form 1040. For example, lets say Mr. Jones originally borrowed $250,000 from
the lender. The lender decides to forgive $150,000. Basically telling the
debtor he or she does not have to pay $150,000. The IRS believes that since you
did not have to pay back the entire loan, then you ended up keeping the money,
therefore it is income.
What if I own a property with a
value less than the mortgage balance, can the difference be forgiven through a
short sale or a foreclosure auction? Can the difference become a deficiency
debt? Will the IRS let me exclude forgiven debt and not look at it as income?
The general answer is yes to all
of the questions. If a lender agrees to a short sale, the uncollected
difference can be forgiven or it can become a personal debt obligation. If the
lender forgives the difference then the amount forgiven can be considered
taxable income. If the lender refuses to forgive the difference, then it
becomes a personal debt obligation. This means a lender or a third party (who
buys the debt obligation from the lender) has the right to legally pursue you
by getting a court ordered money judgment.
If your home ends up selling at a
foreclosure auction for less than what is owed, the uncollected balance is
called a deficiency debt. A deficiency from a foreclosure action can be
forgiven or can become a personal debt obligation. Various states have anti-deficiency
statutes. These statutes prevent a lender from collecting on a deficiency.
Also, the federal government enacted the Mortgage Debt Relief Act of 2007. The
Mortgage Debt Relief Act of 2007 allows taxpayers to exclude income from the
discharge of debt on their principal residence. Debt reduced through mortgage
restructuring, as well as mortgage debt forgiven in connection with a
foreclosure, may qualify for the relief. The act applies to all applicable debt
forgiven between 2007 and 201. It applies up to $2 million for joint filing and
$1 million if filing separately. Make sure you read the act and get a qualified
tax professional to analyze your specific situation.
The IRS has additional exceptions
to the "debt forgiveness is income" rule. The most common situations
when cancellation of debt income is not taxable involve qualified principal
residence indebtedness, bankruptcy, insolvency, certain farm debts, non-recourse
loans and other exceptions established by the IRS. You need to speak with a
qualified accountant or other professional, so you understand your tax
obligations.
What are Anti-Deficiency Laws?
Simply put, an anti-deficiency
law prevents a lender from collecting on a deficiency debt or places limits on
how much a lender can collect on a deficiency debt. A homeowner will not be
held responsible for any deficiency if the property is occupied by homeowner.
Basically, the property must be the homeowners primary residence. The lender
can only recover the property and any proceeds from a foreclosure auction sale.
Anti-deficiency laws do not
prevent a lender from reporting the deficiency to the IRS. Since the lender is
generally prevented from collecting the loss on a sale, the lender can report
the loss to the IRS as forgiven debt.
You can contact your states
attorney general or banking department to learn about any deficiency laws. You
can contact a qualified attorney. There are certain states that limit a lender
to only one lawsuit to collect a mortgage loan debt. So make sure you get a
professional opinion about your state laws.
What happens If I settle a Credit
Card or Business Loan for less than what is owed?
If negotiated properly a credit
card company or lender may agree to settle a business loan or credit card debt.
Normally, the unpaid balance should be forgiven. This brings up an important
principle. In order to get debt forgiveness, it must be in writing!!. Keep this
in mind. Just because the lender verbally tells you the debt is forgiven does
not mean it is forgiven unless it is in writing. There are instances when a
debtor is told the debt is forgiven only to get aggressive collection calls
sometime in the future.
How can I determine What Is Best
for Me?
Ask yourself "What am I
trying to achieve, what are my goals?" Your answer should focus on what
puts you in the best financial position in the short and long term. The focus
should be on reducing your debt obligation with limited long term negative financial
impact. If debt is forgiven, then you may have a tax bill. If the debt becomes
a money judgment, then wages can be garnished or certain assets can be seized.
You will need a qualified team of professional advisers to assist you or you
need to do a fair amount of research. Your advisers can include an accountant,
attorney, and/or a consultant.
Each persons’ circumstance is
unique. It requires spending time listening, gathering detailed financial
information, reviewing all necessary documents and discussing various
strategies.
Now you know so take control.
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